Penalizing the Underdogs? Employment Protection and the Competitive Dynamics of Firm Innovation

This study examines how constraining a firm�s ability to adjust resources affects innovation. In response to losing competitiveness, laggard firms must release obsolete resources and increase experimentation with new resources. Limiting the pace and efficiency at which they can do so impedes their ability to innovate and challenge leaders. I explore these ideas empirically by exploiting the staggered adoption of employment protection laws by U.S. state courts that were intended to protect employees but also had the effect of limiting the ability of laggards to reconfigure human resources. Increasing employment protection indeed results in fewer and less impactful patents by laggards, driven by a decrease in radical innovations that require significant resource adjustments. By distinguishing between firms that have the incentive to adjust resources versus those that do not, the study articulates the process and the black box between constraints on resource adjustment and innovation in a way that explains why the relationship is more complex than a simple average effect. More broadly, this study proposes a firm�s competitive position as a critical yet neglected contingency, complementing the prior emphasis on industry- and task-level considerations.